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Fiscal Policy

“Spending is out of control,” the politician says. “We’re broke.” Fear of government borrowing permeates modern public policy discourse. Important political figures describe government borrowing as a threat to economic well-being, especially that of future generations.

Careful analysis suggests that the effects of U.S. government debt will be remarkably benign in 2012 and years immediately following. Despite the past decade’s large and rapidly rising federal debt, interest rates remain at historic lows and the U.S. government seems to have no trouble borrowing more funds. In the following pages, we explore both logic and evidence to understand the impact of government spending and public debt on economic well being. We also consider more abstract concerns, such as the debt’s effect on future generations, its potential to “crowd out” private economic activity, and the economic consequences of borrowing from foreign countries.

As a first step, we recommend that readers look at the Basic Logic of Fiscal Stimulus. This page explains how government actions raise demand, output, and employment, either directly through higher government spending or indirectly through tax cuts.

The Keynesian-MWM perspective developed in these pages leads to the rather surprising and provocative conclusion that many of our debt-related fears are unfounded. No one is in favor of government deficits, per se, and we accept that government budgets should be close to balanced when the economy is strong. But the policies that create deficits can be critical in improving employment, growth, and overall economic welfare in difficult economic times.